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Seven Steps to Enhancing Your Investment Compliance Monitoring Services

Posted by Lynette DeWitt, Investment Management research manager, Deloitte Services LP, on April 16, 2014

A top concern for fund managers when it comes to investment compliance is that the risk of financial loss from breaching contractual obligations to investors may be significant. This concern is further compounded by the fact that the SEC is ramping up its enforcement actions in regard to compliance issues overall. To underscore this point, SEC Chairman Mary Jo White recently adopted the "broken windows" theory for enforcement, concluding it is "important to pursue even the smallest infractions" as these may lead to larger ones.1

But just how much of an impact will this have? Well, you've probably heard the expression, "If you think compliance is expensive, try noncompliance."2 In 2013 the SEC took in $3.4 billion in monetary sanctions for 686 enforcement actions in 2013. This dollar amount is 10 percent higher than it was in 2012 and 22 percent higher than in 2011.3

In the light of these dual concerns — the risk of financial loss and the risk of enforcement action — how might investment managers take a second look at their investment compliance monitoring (ICM) processes versus that of their peers and align with leading practices? A recent Deloitte survey offers some valuable viewpoints.4

In 2013 Deloitte polled 26 investment managers of varied sizes about their ICM processes. Among these firms, holding a collective $10 trillion in assets, mutual funds were the popular product offered. Twenty-three percent of firms held more than $500 billion in assets under management, 38 percent held between $101-500 billion and 31 percent held under $100 billion.

Here are some of the specific findings from the survey, along with leading practices for your ICM team to consider:

  1. Improve RFP responses — Institutional investors are seeking more transparency around ICM capabilities as early as the request-for-proposal (RFP) process. Fifty-eight percent of investment managers involve the ICM team in the process, yet not to a "significant" extent. Bringing the ICM team into the RFP process early on can help companies lower the risk of overstating or over- committing its ICM capabilities to prospective clients, while reducing costly mistakes in the future.
  2. Enhance client onboarding — During the contract negotiation phase and throughout onboarding, the ICM team provides valuable support around investment restrictions, rules coding and system capabilities. Eighty percent of participants involve their ICM team to a "significant" extent during onboarding processes in order to mitigate portfolio compliance risks. However, nearly one-in-four firms, 23 percent, do not use a standardized set of actions or workflow for onboarding, indicating the need for firms to focus more on on-boarding process controls.
  3. Standardize handling of interpretative issues — Sixty-eight percent of participants lack specific procedures for identifying and resolving interpretative issues. Ideas for handling these issues include cross-functional committees, the use of investment contract templates and centralized tracking procedures.
  4. Enhance breach management — Breaches are costly for financial, reputational and regulatory reasons. One-in-five organizations still experience more than 50 breaches per year, with the payout per breach averaging nearly $10,000 for 62 percent of participants. Proactive breach prevention measures include performing root-cause analysis on breaches, conducting forensic testing into patterns of validated breaches and resolving false alerts in ICM systems.
  5. Address data limitations — It is important to assign resources and establish workflows to address data limitations, especially in light of the growing regulatory interest around data and reporting. While 88 percent of participants have personnel assigned to monitoring data quality, there is still work to be done on manual rules monitoring in terms of data limitations, the use of data dictionaries and other related data quality areas.
  6. Assess ICM-related IT capabilities — With many ICM systems aging (44 percent of participants have been using their automated ICM system for more than 9 years), special consideration should be made to cost, personnel and customization, in order to support the escalating demands of portfolio compliance on the ICM system.
  7. Understand ICM costs — Costs for the ICM process may be more clearly understood through installing tracking measures for areas that can be measured and through understanding the intrinsic costs shared between areas of the firm that support the ICM system — namely marketing, client relations, regulatory compliance and risk management. Specific ICM-related costs are important to assess as well, especially those related to potential breaches and the monitoring process. For example, the survey revealed that eighty percent of participants do not determine the costs associated with monitoring atypical investment restrictions.

As you review these insights relative to your organization, consider one last point: the pursuit of operational excellence in ICM is not just for its own sake. The rest of the organization benefits as well. Improved ICM capabilities assist an investment manager in responding to both internal and external pressures — and as such, can be dubbed a "linchpin" of risk mitigation activities.

1 Mary Jo White, "Remarks at the Securities Enforcement Forum," U.S. Securities and Exchange Commission, October 9, 2013.
2 Credited to Former Deputy U.S. Attorney General Paul McNulty.
3 U.S. Securities and Exchange Commission, "SEC Announces Enforcement Results for FY 2013," press release, December 17, 2013.
4
Michael Fay and Miguel Miranda, "Investment Compliance Monitoring Survey, Moving Forward with a Sharper Focus," second edition, Deloitte Development LLC, 2014.

As used in this document, "Deloitte" means Deloitte LLP [and its subsidiaries]. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting.

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